Why RBI should hold interest rates for now

August 4, 2020 7:30 AM

The other aspect that the markets will look closely to the central bank for is its guidance on a one-time restructuring or extension of the moratorium

Another aspect is whether RBI will further widen the repo/reverse repo corridor.Another aspect is whether RBI will further widen the repo/reverse repo corridor.

By Shanti Ekambaram

The COVID-19 pandemic has altered lives and livelihoods and, thus, the movement of the wheels of the economy as we know it. Most large economies globally, including India, are staring at uncertain and challenging times. Liquidity is sloshing around in the system, and it is keeping rates soft.

To give a stimulus to the economy, the Monetary Policy Committee (MPC) of RBI has cut the repo rate by a cumulative 155 basis points since February 2020. This was done at a time when inflation levels were above RBI’s medium-term target of 4%. However, unprecedented times call for unprecedented measures, and RBI’s single-minded focus has rightly been on reviving the economy given the ongoing lockdowns and, in turn, their impact on growth. COVID-19 has, in the short term, changed RBI’s rate-setting narrative.

These measures, however, have not had too much impact on reviving growth or stimulating demand. The COVID-19 pandemic has severely impacted both businesses and consumers and the large-scale economic and job uncertainty with no visibility on when the situation will improve has resulted in muted demand and many supply-side disruptions.

On the demand side, people are sticking to spending only on essentials like groceries, medicines and other spends that support the new norm of working from home. Discretionary spends on categories such as travel, hotels, dining, and consumer goods like electronic items is muted. In addition, it is uncertain just when life will return to normal. With different parts of the country continuing to be in varying stages of lockdowns, we now expect this ambiguity to extend till the end of Q2 at least, making it difficult for businesses to get back to normal and disrupting the supply side.

Against this backdrop, there are two schools of thoughts. First, with economic growth still elusive, the MPC can cut rates by another 25 bps in the hope that it provides further support to the economy. However, rate cuts have not really resulted, thus far, in boosting economic growth. The other option is to pause and monitor the situation over the next two months, with the rate cuts having been front-loaded and inflation still above the 6% mark. Also, the fiscal deficit in the first three months of FY21 is at 83.2% of the annual budgeted number. Given this, the MPC could choose to adopt a wait-and-watch approach for now, observe and analyse the key data prints over the next two months, and take a call to cut rates in the next policy meeting, which is traditionally around India’s festive season and start of a busy period.

My view is that it should go for the latter approach; keep the policy rate unchanged right now, give people more time to absorb the earlier rate cuts and, depending on the macroeconomic outlook then, cut 25 basis points in October. Inflation being above 6% in Q1 is also a cause for concern, though, inflation has been trending down and is expected to moderate further in Q3 this fiscal given the favourable base effect.

In addition to the rate cut, the other aspect that the markets will look closely to the central bank for is its guidance on a one-time restructuring or extension of the moratorium for specific segments. It is possible that the central bank may wait till the end of August when the current moratorium comes to an end to make its decision after reviewing additional data.

Another aspect is whether RBI will further widen the repo/reverse repo corridor.

Overall, we are at close to the lowest we have seen in interest rates. But demand continues to remain sluggish. In the quarter ended March 2020, India’s current account witnessed a surplus of $0.6 billion as against a deficit of $4.6 billion in the quarter ended March 2019, primarily due to a sharp fall in imports. GDP growth this year is likely to be in the negative.

Given the mixed trends on inflation, I would expect RBI to pause this time around. However, the MPC faces some tough choices and I expect that it will be a very close call.

The author is Group president (consumer banking), Kotak Mahindra Bank Views are personal

Get live Stock Prices from BSE, NSE, US Market and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.

Financial Express is now on Telegram. Click here to join our channel and stay updated with the latest Biz news and updates.

Next Stories
1No time to be complacent on Covid-19
2Lost Reasearch: Many online-only open-access journals have “gone dark” with publishers unable to maintain these
3India needs social entrepreneurs